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# American Journal of Engineering Research (AJER)

2016

## American Journal of Engineering Research (AJER)

e-ISSN: 2320-0847 p-ISSN : 2320-0936
Volume-5, Issue-1, pp-42-48
www.ajer.org
Research Paper

Open Access

## Two-Part Tariff Model Formulation for Bulk Sale of Energy by

Depreciating the Plant Using Declining Value Method
Osita Oputa
Department of Electrical/Electronic Engineering Michael Okpara University of Agriculture, Umudike, Nigeria.

ABSTRACT: The electric power sector may be aimed at making life meaningful and comfortable for man, but
making profit while this is been done cannot be exempted. However, the supplier must keep his tariff at
competitive prices to keep his costumers while he makes profit especially in a competitive market. It is important
for the bulk seller of electric energy to know the best tariff that can guarantee this from the very start of the
business. This paper shall develop a mathematical model the bulk electricity seller can use in fixing a two-part
tariff that will be both profitable to himself and affordable to his customers. This model will be developed on the
basis of depreciating the power generating plant by the diminishing value method of calculating depreciation.
This model reveal how a 490MW power generating plant of \$480 million installation cost with a life span of 42
years and a targeted \$24 million profit at the end of the investment (the end of the plant useful lifetime) can be
archived by using a two-port tariff. Testing of the developed model revealed tariffs of \$6.4385/kWh and
\$0.0018/kWh as variable and fixed tariff respectively for the first to three years of plant life time. At the plants
last three years of existence, the energy bulk seller sells energy at variable energy tariff as \$5.4882/kWh and
\$0.00882/kWh as fix energy tariff. With this, the investor can know how to set and vary energy tariff that can
generate his expected profit at the end of the investment.
Key word: Model fixing two-port tariff.
NOMENCLATURE
IC
Installation cost of the Plant (\$).
S
Salvage value of plant after m years
(\$).
m
Cash deposit to be made for between
year g and h (\$).
x
Rate of depreciation per annum.
n, g, h 1, 2, 3 . year.
Value of plant after nth year.
TI
Cash paid for tax and insurance per annum(\$).
r
Interest rate (% of IC).
I
Interest paid on capital per annum (\$).
MC
Expected/estimated maintenance cost per annum (\$).
MPD Maximum power delivered (MW)
K
Fix tariff (\$/kWh).
Variable tariff for g to h year (\$/kWh).
SW
Expected salaries/wages per annum (\$).
M
Expected Miscellaneous expensive per annum (\$).
PT
Expected total profit to be made in the investment (\$).
P
Expected profit to be made per annum (\$).
a
% of installation cost to be made as profit by investor
FC
Annual Cost of fuel burnt (\$)
Lf

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## American Journal of Engineering Research (AJER)

I.

2016

INTRODUCTION

The rate at which electric energy is sold to consumers is known as tariff. Fixing tariff for bulk sale of electricity
especially in a competitive market shall be examined in this paper; a two-part tariff plan shall be considered in
this paper. This two-part tariff consists of the fix and variable tariffs. The bulk sellers of electricity are the
generation companies selling energy to transmission companies. For a market with many sellers and buyers of
this commodity, the tariff of the electricity sold by these generation companies should be done considering
among others the following.
(i) Ability/Willingness of the consumer to pay
(ii) Cost of generating and transmitting of the electric energy (which comprise of the fixing and running
cost);
(iii) Quality of Services rendered.
Out of the above three factors, the second factor is the only factor that is quantifiable [1].
At the end of the useful life time of the power plant, it should be replaced so as to keep the supplier in business;
hence, cash allocation for the replacement of the plant should be in considered while the plant running healthy.
Inflation and interest rates should also be strongly considered when fixing tariff. This is because these monies
set aside for the replacement of the power plant will have appreciated by the time the replacement is due. Also,
inflation may catch up with the monies reserved for the plant replacement.
In this paper, the plant will be depreciated using the declining value method. In this method, the value or worth
of the plant at the end of the first year is taken as the worth of the plant at the beginning of the second year and
so on.
1.1

## ADVANTAGES OF THE DEPRECIATING THE PLANT BY DECLINING VALUE METHOD

1.
2.

The value of the plant at the beginning of every year is not taken as the initial or installation cost but as
the value of the worth at the end of the preceding year.
This method gives higher tariffs at the initial stage of the business when the plant efficiency is high and
encouraging to costumers.

## 1.2 DISADVANTAGES OF THE DEPRECIATING THE PLANT BY DECLINING VALUE METHOD

1.
2.
3.

The method does not take appreciation of deposit made at early stages of the plant into consideration at
the time when the plant will be salvaged.
This method is associated with high tariff at the initial stage of the business. It is bad to give more
financial obligations to a new business with little customers by setting high initial tariff.
The early stage encounter the challenge from the manufacturers error which may cause reduced
reliability; hence, setting high tariff at this stage may not be fair.

II.

## MODEL FOMULATION FACTORS

The formulation of the model to be used to determine electric energy bulk sale will depend on a number of
parameters. These among others include
1.
2.
3.
4.
5.
6.
7.
8.
9.

## Cost of fuel source to be burnt during the period under analysis.

Taxation and Insurance.
Depreciation of the power plant over its expected useful life time.
Interest payable on invested capital.
Expected profit (a percentage of the invested capital).
Expected energy to be generated in the period under analysis.
Estimated maintenance cost during the period under analysis.
Estimated salaries and wages of staffs throughout the period under analysis.

## 2.1 Expected Annual Cost of Fuel Source

This is the cost of the primary source of fuel burnt annually for the generation of the expected power. The actual
quantity of fuel will not be constant for the entire life time of the plant. As the plant is ageing, the expected fuel
cost per annum of running the power will be increasing as long as the net output power of the plant will be
unchanged. To compensate for this increase, 2% rise in fuel consumption will be adopted at the end of every ten
years of the plants life time.

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## American Journal of Engineering Research (AJER)

2016

For first three years of the plant (0-3 years), annual cost of fuel burnt is \$FC.
The plant life of 04 -06 years, annual cost of fuel burnt is \$1.02FC.
Between 07-09 years, annual cost of fuel burnt is \$1.04FC and so on.
2.2 Cash reservation due to depreciation
They say nothing last forever; so, the plant that is commissioned for use today that is expected to run for a
useful life time of m years will surely be uneconomical in the power generation business after its useful life
time. Hence, a good businessman will make reservation to replace the power generating plant be the end of its
useful life. The cash reservation should be made during the useful life time of the plant.
In this paper, the declining balance depreciation method will be used for computing monies to be set aside for
cash reservation for the replacement of the plant at the end of its useful working years.
Using the declining balance depreciation method, the value of the plant at the end of the nth year is
(1)
Where

(2)

## Hence, the cash deposit to be made at the end of each year is

(3)
The deposited cash for any 3 consecutive years is,
(4)
2.3 Servicing of interest due to collected loan
Most businessmen will never invest with their own capital; they will rather take loans from the banks. These
loans will have to be serviced and the servicing must be included in the model formulation for fixing of the
tariff.
2.4 Estimated maintenance cost
This includes all expected daily, weekly, monthly and annual maintenance expenditures that will be made
during the period under analysis for the running of the plant. It include expected rotten plant inspection and
maintenance cost. This will not be constant all through the life time of the plant, as the plant is aging,
maintenance activities on the plant will be more frequent; hence, the maintenance cost of the plant per annum
should increase by a percentage, say 10% in every 3 years.
2.5 Expected Profit
The profit the investor should want to make is a major determinate of the tariff of the power that will be
generated. No doubt, the profit should be such as to encourage investment in the power sector; but the investor
should place his profit margin in such a way that consumers will be willing to buy his power (especially in a
competitive market). The profit should be a very small percentage of the investment cost and should be spread
throughout the lifetime of the plant.
(5)
As this will be spread throughout the lifetime of the plant, a profit of
In the running of the power plant during the period under analysis, it is certain that the plant maximum power
(plant capacity) will not be demanded throughout this period; at some times, an average load will be demanded
from the plant. The load factor is the ratio of the expected average load demanded from the plant to the expected
maximum load demanded during this period.

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## American Journal of Engineering Research (AJER)

2016

(6)
In actual fact, the Lf decreases as the plant is aging.
2.7 Period Under analysis
Cost of fuel throughout the life time of the plant cannot be the same; this can be due to inflation and increase of
fuel cost, ageing of the plant among others. This period could vary from plant to plant depending on the source
of fuel (most importantly). For example, a gas turbine plant uses natural gas whose price is control by the
international market and could change easily, analysis of such plant should not exceed three to five years at a
time. In this paper, a three-year analysis period shall be used.
2.8 Wages and salaries (SW)
An estimate of what should be spent annually on salaries and wages should be known from the start of the
2.9
Fixed Charge or Tariff (K)
The electric power supplied by any plant is not constant; hence, it will be beneficial for any generation company
to charge his client by using a two part tariff the fix and variable charges. The fix charge is the amount paid by
the client when ever power is supplied to the client irrespective of the power supplied; i.e, this tariff does not
varies with the power supplied. In this paper, the fix tariff will be slightly increased by +0.3 at the beginning of
a new the period of analysis from the preceding one (say 3 years as will be used in this paper).

III.

MODEL FORMULATION

As stated earlier, a 3-year analysis period shall be used in this paper. However, using a smaller time frame will
result more number of equations but will give more accurate results. Now combining all the expensive incurred
in running the plant for a 3-year interval plus 3 times the expected annual profit; should be equal to the total
money realized from sale of energy for the 3 years.
Considering the first 3 years of the plant,

(7)
The nest 3 years,

(8)
.
.
.
.
The last (kth) three years

(k)

The sum of the RHS of equations (7) to (k) is the sum of the present worth of the installation cost and the total
profit to be made at the end of the investment by the investor.

(9)

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## American Journal of Engineering Research (AJER)

IV.

2016

DEVELOPMENT
1. It was assumed that the maximum output power delivered by the plant will be constant throughout its
2. The system is free from inflation.

V.

MODEL TESTING

The model developed in this paper shall be tested with Nigeria's first ever Independent Power Plant (IPP),
capable of generating 490MW of electricity, commissioned by Former Nigerian President Olusegun Obasanjo at
Okpai in Delta State. This plant has a capital cost of \$480million and uses 75 million standard cubic feet of gas
per day (scfd) for its operation.
The parameters of the power plant are given below
TABLE 1: PLANTS DATA (Source: [5])
ITEM
IC
TI
M
Lf
(070% of
FC
r
x
PT

VALUE
\$480M
\$25,000
\$100,000
0.896

\$1,200
5%
8%
\$24M

ITEM
S
MC
SW
Lf (71100% of
MPD
m
a

VALUE
\$30M
\$50,000
\$200,000
0.850

460MW
30 years
5%

## Using these data,

(10)
The cash deposits for every three years is given below
TABLE 2: COMPUTED CASH DEPOSIT TO BE MADE IN STATED PERIODS
PERIOD (YEAR)
13
46
79
10 12
13 15
16 18
19 21
22 24
25 27
28 30
31 33
34 36
37 39
40 42

86.39
70.83
58.10
47.63
39.07
32.03
26.27
21.54
17.66
14.12
11.88
9.74
7.99
6.55

(11)

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2016

## Tariff model for 4th to 7th years is

(12)
.
.
.

(24)
and

(25)
Finding the solution to these fifteen set of equations (11 25) using MATLAB gives the following values:
TABLE 3: OBTAINED VARIABLE AND FIX TARIFFS FOR STAGES OF PLANT

6.4385
6.2925
6.1752
6.0809
6.0061
5.9467
5.9003
5.8644
5.8371
5.8133
5.5048
5.4958
5.4905
5.4882
0.0018

Using these results, the tariffs for the respective periods can be formulated as given in table 4.
TABLE 4: TARIFF FOR PERIODS UNDER ANALYSIS
S/N

PERIOD
(YEAR)

1
2
3
4
5
6
7

13
46
79
10 12
13 15
16 18
19 21

VARIAB
LE
TARIFF
(\$/kWh)
6.4385
6.2925
6.1752
6.0809
6.0061
5.9467
5.9003

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FIX
TARIFF
(\$/kWh)

TOTAL
TARIFF
(\$/kWh)

0.00180
0.00234
0.00288
0.00342
0.00396
0.00450
0.00504

6.4403
6.2948
6.1781
6.0843
6.0101
5.9512
5.9053

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## American Journal of Engineering Research (AJER)

8
9
10
11
12
13
14

22 24
25 27
28 30
31 33
34 36
37 39
40 42

5.8644
5.8371
5.8133
5.5048
5.4958
5.4905
5.4882

0.00558
0.00612
0.00666
0.00720
0.00774
0.00828
0.00882

VI.

2016

5.8700
5.8432
5.8200
5.5120
5.5035
5.4988
5.4970

SYSTEM ANALYSIS.
1. Dollar rate of 2003 was used in the analysis.
2. An assumed Interest rate of 8% of the capital was used for the analysis.
3. A life span of 42 years was used as the actual 30 years was for when the plant 24 hours per day for its
entire life time which is practically impossible as a result of shunt down during maintenance, e.t.c.
4. The fuel here is a by-product of petroleum exploration; hence, no increase over the years was taken into
account as most part of the fuel cost is the capital cost of the gas line from the flow station where the
petroleum exploration is taking place to the gas plant.
5. A profit of 5% of capital cost of the project was assumed to be targeted by investor.
6. It was assumed that the fixed tariff will be increasing at a rate of 30% at the end of every 10 years.

VII.

DISCUSSION OF RESULTS

As observed, the energy tariff at the first three years was highest with total tariff at \$6.4403/kWh (\$6.4385/kWh
and \$0.0018/kWh for variable and fix charges respectively). The investors plant operates at its highest
efficiency at this stage and therefore provides the best services to energy buyers; his product will therefore be
highly demanded and will get good patronage at that price. As time goes on, say between sixteen to eighteen
years, the efficiency of the plant will not be as in the first three years, there will be more frequent turn around
maintenance resulting to frequent outage. The investor tries to keep his business and costumers by crashing his
energy tariff to a total of \$5.9512/kWh (\$5.9467/kWh and \$0.0045/kWh for variable and fix charges
respectively). The tariff continue declining as systematically planed until the last three years of the plant when
the tariff becomes a total of \$5.4970/kWh consisting of variable energy tariff as \$5.4882/kWh and
\$0.00882/kWh as fix energy tariff. With this, the investor is fully aware that at the end of the 42-year period, he
will make a total profit of 5% of the installation cost of the project. He also knows how to place his tariff at any
particular time throughout the plants so as to make his desired profit.

VIII.

SUMMARY

By using this model, a proper plan can be made by any investor of how he can fix his energy tariff from the start
of the power plant working life to the end its end that will generate the extract or desired profit the investor
wishes to make. The implication of using this model in a country like Nigeria is that energy tariff may rise
unless governments will as usual subsidence it for her citizens.

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